Is Pipestone Energy (TSE:PIPE) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Pipestone Energy Corp. (TSE:PIPE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Pipestone Energy

What Is Pipestone Energy's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Pipestone Energy had CA$237.8m of debt, an increase on CA$165.2m, over one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Pipestone Energy's Liabilities

We can see from the most recent balance sheet that Pipestone Energy had liabilities of CA$85.9m falling due within a year, and liabilities of CA$301.5m due beyond that. Offsetting this, it had CA$426.0k in cash and CA$32.3m in receivables that were due within 12 months. So its liabilities total CA$354.6m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's CA$306.3m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Pipestone Energy can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Pipestone Energy wasn't profitable at an EBIT level, but managed to grow its revenue by 89%, to CA$169m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Pipestone Energy's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at CA$26m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CA$93m in negative free cash flow over the last year. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Pipestone Energy , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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